What Share Is Fair?

An academic paper contends that pay-for-perfomance policies may not motivate the unrewarded to work harder.Alix Stuart, CFO MagazineDecember 1, 2009

Even in a year when bonus pools are shallow, if not completely dry, few would dispute the merits of merit-based pay. In fact, many companies are planning to widen payout differences among employees, says Ilene Gochman, director of Watson Wyatt's organization effectiveness practice, because they want to make sure top performers feel appreciated. While that is sure to create some disgruntlement among average performers, "the system should, in theory, motivate them to try harder," she says.

But a recent paper by two Washington University in St. Louis business-school professors, Jackson Nickerson and Todd Zenger, argues that companies shouldn't disregard one negative impact of pay-for-performance: the envy it can beget. They contend that the get-nots will not necessarily work harder, and in fact may reduce their own efforts and sabotage others by not cooperating with better-compensated colleagues. CFO recently spoke with Nickerson about this unconventional wisdom.

How should CFOs think about divvying up smaller-than-normal bonus budgets this year?If you don't have much to give, then you give it equally. That's particularly true in times like these. When the organization is stagnant or shrinking, that's when people are going to be the most concerned about equity. If you give to one, it directly implies you're taking away from the others.

Would you go so far as to say it's inadvisable to use pay-for-performance plans?Pay-for-performance can work, but only under very specific circumstances. You have to be able to precisely monitor and measure productivity, and there can't be any judgment involved. As soon as you have a nonquantitative measure, it turns out that pay-for-performance is not so good. It's the Lake Woebegone syndrome; we're all overconfident in our abilities.

What other things, besides pay, tend to spark envy within companies?Three-quarters of all mergers and acquisitions fail, and we believe social comparison [or envy] is a prime culprit. What frequently happens is that people from one organization get the plum jobs while the other ones don't. Also, you often have a large firm [with tougher performance targets for incentive pay] acquiring a smaller firm and wanting to impose the same structure there. Instead, you should keep the compensation structure of the acquired firm, and credibly commit to your employees that there's a career path to get them to the higher-paying jobs.

Motivation DeteriorationA recent survey of top performers across industries indicates they feel less motivated by their pay packages than they did last year.

Among the best and brightest, 20% fewer believe that their performance goals are linked to their company's strategy and goals, 37% fewer think their supervisor ties rewards (compensation) to organizational performance, and 24% fewer say their performance objectives are motivating.